Global Economics

Green Diesel? Mercedes Takes on Japan

If any foreign auto maker can be confident of launching a successful new model in Japan right now, it's probably DaimlerChrysler's (DCX) luxury unit Mercedes Benz. Spurred by a raft of new vehicles in 2005, sales of the luxury brand rose 4% last year in Japan, compared to a 0.4% decline for the market as a whole.

In 2006, the German brand's sales are surging even faster -- by more than 30% in January and February compared with a year earlier -- as Japanese carbuyers have been wooed by remodeled versions of the S-Class luxury sedans, A-Class compact, and M-Class SUVs and all-new designs of the B-Class MPV and CLS-Class saloons. Toyota (TM) launched its Lexus brand in Japan last August, but so far the results have been less than dazzling. "In Japan, the novelty effect [of new models] is stronger than anywhere," says Hans Tempel, CEO of DaimlerChrysler Japan in Tokyo.

Nevertheless, when Mercedes launches a diesel version of its E-Class luxury sedan later this autumn, industry analysts will be watching Japanese auto buyers' reactions more closely than usual. After all, by offering a diesel version of its E-Class, Mercedes will be treading where few local auto makers have been prepared to venture.

DIRTY REPUTATION. While diesel-powered engines are the norm in Europe, in Japan such cars are almost non-existent. "In Japan when you say diesel engine, everyone thinks of rattling, smelly, dirty engines," says Tatsuo Yoshida, an analyst at Merrill Lynch in Tokyo. "Demand is almost nil at this moment."

Diesel cars accounted for more than 6% of industry car sales at the start of the 1990s. However, tougher regulations governing nitrogen oxide emissions, and perceptions that diesels were dirty (partly because of the poor quality of diesel sold in Japan at the time) and had relatively poor engine performance led to a rapid decline in sales over the last 15 years.

By last year, just 1,800 diesel passenger cars were registered in Japan -- equal to 0.4% of the overall market compared to more than 50% in Europe. What's more, whereas in 2002 there were 24 diesel passenger cars on the market in Japan, today there's only one -- Toyota's Prado Land Cruiser SUV. DaimlerChrysler itself withdrew its last diesel models from the market Japan in 2002.

GREENER DIESELS. Economics is also a factor. While diesel is about 25% cheaper than gasoline in Japan, tax changes have narrowed the gap with gas engines. And because the Japanese tend to drive relatively little compared to Europeans and Americans -- typically about 6,000 miles a year -- the benefits of great fuel economy from diesels are less pronounced, particularly as diesel engines cost more to produce. For example, Honda's (HMC) diesel CR-V, sold in Europe, costs $2,400 more than the gasoline version in Britain.

Yet for all that, DaimlerChrysler's Tempel is confident that a diesel Mercedes can make a mark in Japan. One big factor is that many of diesel's perceived weaknesses no longer hold true. Today's clean diesels offer lower carbon dioxide, or CO2, emissions and greater fuel economy than gas engines while nitrogen oxide emissions have been greatly reduced. The quality of diesel fuel on sale in Japan has also improved as oil companies have reduced sulfur levels. "You still have the economic advantage -- but without any additional burden for the environment," says Tempel.

JUST TRY IT. The notion that diesels don't offer high performance also no longer applies. DaimlerChrysler isn't yet saying which version of E-Class it will sell in Japan or how much it will cost, but it's currently testing the European version of the 3.2 liter E320 CDI in Japan. Generating 201 horsepower, the turbo-charged E320 CDI is no slouch, accelerating from 0-60 mph in 6.6 seconds and with a top speed of 155 mph.

Tempel is confident that that kind of performance, combined with over 37 mpg fuel efficiency, will help shatter perceptions in Japan. "There's only one way you can convince the customer and that's to give him the experience of driving a diesel car," Tempel adds.

In time, experience and some high-profile advertising campaigns highlighting the strengths of diesels could be enough to bring more diesels back to Japan's roads. Kazumi Yanagisawa, a researcher at the Yano Research Institute in Tokyo, projects that the diesel penetration rate in Japan could reach 11% by 2015. Still, don't expect Japanese auto makers to rush out a host of new diesels overnight.

ANY FOLLOWERS?. Toyota, Honda, and Mazda (MZDAF) already sell clean diesels in Europe but none have announced plans to launch new diesels in Japan. Similarly, No. 2 auto maker Nissan (NSANF), which doesn't currently sell diesel engine passenger vehicles but has access to the technology through its alliance with Renault, says it's monitoring the situation in Japan.

And on Mar. 24, when Fuji Heavy Industries CEO Kyoji Takenaka said Subaru would begin making diesels by the end of 2007, he said the focus will initially be on the European market. When it comes to diesels in Japan, Mercedes seems to be the lone warrior, at least for now.